Supreme Court to Hear Dispute Over Fees for Defending Fee Application

The Supreme Court doesn't take many cases on bankruptcy issues.  It has only ruled on attorney's fees in bankruptcy once since the Code was adopted and that ruling was on the narrow issue of whether a chapter 7 debtor's attorney could recover fees from the estate.    As a result, it was big news when the Court granted cert in  No. 14-103, Baker Botts, LLP v. ASARCO, LLC on October 2, 2014.    The issue in ASARCO is whether an attorney can recover fees for defending his fee application or whether those expenses are merely "a cost of doing business" as held by the Fifth Circuit.   The issue matters in the particular case because Baker Botts spent $5 million in time defending its $113 million application.   

What Happened

I have previously written about the ASARCO case at length here.   This was a case where the Debtor's law firms obtained a judgment against the Debtor's parent company for somewhere between $7 and $10 billion which was "the largest fraudulent transfer judgment in Chapter 11 history."    As a result of the adverse judgment, the Debtor's parent company decided to fund a plan which paid the creditors in full and left the Debtor with $1.4 billion in cash.   

Given this incredible result, the Debtor's law firms should have had an easy time recovering their fees.  After all, when you are measuring results in the billions, what's a hundred million in fees?   However, under the Plan, ASARCO's parent regained control of the Debtor.   They were apparently not happy about paying Baker Botts and Jordan Hyden for having sued them.   

 

The Debtor submitted a discovery request to Baker Botts which required it to produce every document it had prepared in 52 months of bankruptcy.    This amounted to 2,350 boxes of hard copy documents and 189 GB of electronic data.   In case you were wondering, 1 GB of data translates into between 65,000 to 165,000 pages of documents depending upon whether the documents were Microsoft Word documents, Excel spreadsheets or emails.   Assuming 100,000 pages per GB of electronic data, that means that Baker Botts produced about 18.9 million pages of electronic documents.   (Imagine being the associate who had to review all that!)  

Notwithstanding ASARCO's efforts to contest its firms' fees, the Bankruptcy Court awarded Baker Botts $113 million in fees, an enhancement of $4.1 million and $5 million for defending its application and awarded Jordan Hyden $7 million in core fees, an enhancement of $125,000 and $15,000 for prosecuting the application.

On appeal, the Fifth Circuit upheld the fee enhancements but struck down the cost of defense fees.   ASARCO, LLP v. Jordan Hyden Womble Culbreth & Holzer, P.C. (In re Asarco, LLC), 751 F.3d 291 (5th Cir. 2014), cert. granted, 2014 U.S. LEXIS 4913 (10/2/14).   

Having been mostly successful, Baker Botts decided to go to the Supreme Court for the last $5 million which was withheld.    In filing their petition, Baker Botts was supported by the State Bar of Texas Bankruptcy Law Section and the Business Law Section of the Florida Bar.  

Why It Matters

In its opinion, the Fifth Circuit made a brief though cogent examination of section 330(a) in denying the cost of defense fees.  In particular, it ruled that section 330(a)(3) and (4) require that services be likely to benefit the estate or necessary to the administration of the estate in order to be compensated.  

Nevertheless, Section 330 states twice, in both positive and negative terms paraphrased above, that professional services are compensable only if they are likely to benefit a debtor’s estate or are necessary to case administration. Matter of Pro-Snax Distributors, Inc., 157 F.3d 414, 418 n.7 (5th Cir. 1998). The primary beneficiary of a professional fee application, of course, is the professional.

Opinion, p. 13.   The Court also concluded that because section 330(a)(6) allows fees for preparing a fee application but not for litigating one, that cost of defense fees must be denied.   

This case has both the statutory interpretation questions mentioned above and the policy question of whether one party can impose litigation costs upon another party with impunity.   Here, there is a strong hint that ASARCO's parent, now in control of the Debtor, sought to get payback against Baker Botts by running up the cost of getting compensated.   It seems curious that the Debtor would have needed to request every piece of paper created by the firm in order to judge whether their fee request was reasonable.    While the Fifth Circuit raised the prospect that fees could be awarded for vexatious fee objections, it also suggested that fees were not litigated often enough, stating:

“Too frequently, court-appointed counsel for debtor[’s] and the official creditor committees’ interests in a case, sharing the mutual goal of securing approval for their fees, enter into a conspiracy of silence with regard to contesting each other’s fee applications.”

Opinion, p. 18.

The result in this case is likely to be important beyond the narrow issue presented for the following reasons:

• Supreme Court watchers have noted that the Court's bankruptcy decisions tend to swing between strict textual analysis and a functional approach.   If the Court goes with the textual approach, it will be likely (though not guaranteed) to uphold the Fifth Circuit, while a functional approach would support Baker Botts.
• The Court will be required to address the meaning of likely to benefit the estate and necessary to case administration.    Because these terms are critical to interpretation of section 330, the court's opinion will provide valuable guidance on awarding fees.   While the Fifth Circuit's view that defending a fee application was for the benefit of counsel is plausible, I believe that the better answer is that it is part of the process of administering the estate.
• The Fifth Circuit's opinion relied on one of the multiple rationales of the Pro-Snax case.  While the Court's interpretation of Pro-Snax in ASARCO was consistent with the statute, the mere fact that the case is before the Supreme Court may encourage the Fifth Circuit to walk back Pro-Snax's most aggressive holding that only actual results may be compensated.   In its amicus brief in support of the petition for cert, the State Bar of Texas Bankruptcy Law Section raised the Pro-Snax "results only" holding and mentioned my firm's case of Matter of Woerner, 758 F.3d 693 (5th Cir. 2014), which is currently the subject of a pending request for rehearing en banc.    

The importance of the case is also underscored by the fact that representatives from two state bars weighed in on the dispute.   In my experience, it is highly unusual for a section of the Texas State Bar to file an amicus brief.  I am not aware of any other case in which it has been done.   While I am speculating here, I have to believe that the Bankruptcy Section must have convinced the State Bar that this was an issue of importance to lawyers in general.    Otherwise, they would just have been taking sides in a dispute between different groups of lawyers.    This will be an interesting case to watch.

Lessons on Fees from the Fifth Circuit's ASARCO Decision

While the Fifth Circuit has yet to definitively address the quirky Pro-Snax opinion, a new decision provides some helpful guidance on recovering attorneys' fees in bankruptcy.    ASARCO, LLC v. Jordan Hyden Womble Culbreth & Holzer, P.C. (Matter of ASARCO, LLC), No. 12-40997 (5th Cir. 4/30/14).    You can read the opinion here

What Happened

ASARCO was a copper mining, smelting and refining company.  It used to have a really big smokestack in my home town of El Paso, but that's another story. Two years before bankruptcy, ASARCO's parent, Americas Mining Corporation (AMC), directed ASARCO to transfer a controlling interest in Southern Copper Corporation to it.   After ASARCO filed chapter 11 in 2005, its attorneys, Baker Botts and Jordan Hyden Womble Culbreth & Holzer, filed a fraudulent transfer action against the parent company.    The attorneys did a really good job.   They recovered a judgment valued at between $7-$10 billion which, according to the Fifth Circuit "was the largest fraudulent transfer judgment in Chapter 11 history."    When ASARCO sought to monetize its judgment, AMC decided that it would be cheaper to fund the company's reorganization instead.   As a result, ASARCO emerged from bankruptcy after just  52 months with "little debt, $1.4 billion in cash, and the successful resolution of its environmental, asbestos and toxic tort claims."    

You would think that everyone would be very happy with the work done by the attorneys.    The two firms applied for their lodestar fees plus a 20% enhancement as well as their expenses for preparing and litigating their fee applications.    ASARCO, which was now under the control of its parent, challenged the fees.   One discovery request sent to Baker Botts requested every document that the firm had produced during the bankruptcy case.   This resulted in production of 2,350 boxes of documents plus 189 GB of electronic data.   

After a six day trial, the Bankruptcy Court awarded Baker Botts $113 million in fees plus an enhancement of $4.1 million for the work performed on the fraudulent conveyance case.   Jordan Hyden recovered $7 million in fees as well as an enhancement of $125,000.   The Court also awarded fees for defending the fee applications, which amounted to $5 million for Baker Botts and $15,000 for Jordan Hyden.  

The District Court affirmed.

The Fifth Circuit's Ruling

The Fifth Circuit affirmed the enhancements but denied the fees for defending the fee applications.   Its analysis recapped the three-pronged approach adopted by the Court in In re Pilgrim's Pride Corp., 690 F.3d 650 (5th Cir. 2012) in which the Court held that fees should be determined under a combination of the lodestar approach, the factors specified in 11 U.S.C. Sec. 330(a) and the twelve factors from Johnson v. Georgia Highway Express, Inc., 488 F.2d 714 (5th Cir. 1974).    The Court explained that

Section 330(a), the lodestar method, and the Johnson factors work in conjunction with each other to guide the court's discretion.

Opinion. p. 6.   The Court further explained that the lodestar calculation (reasonable rates multiplied by a reasonable number of hours) provides the starting point for the analysis and that the lodestar amount can be adjusted up or down based upon the other factors.    The fact that the lodestar can be adjusted up provides the analytical basis for fee enhancements in "rare and extraordinary cases."   

The Court rejected challenges from ASARCO that fee enhancements could never be allowed, that enhancements had to be approved by the client and that enhancements could only be allowed where there was a "plus factor" in addition to extraordinary results.  

The Court also considered whether Baker Botts's fees were "below market" as found by the Bankruptcy Court.   The firm's blended rate was $353.98 per hour with partners charging $365-$800 per hour and associates billing $$195-$525 per hour.   The Court ruled that because "reasonable attorneys' fees in federal court have (not) been 'nationalized,'" it was improper to look at fees charged in other circuits.   Opinion, p. 10.   Nevertheless, the Court found that the Bankruptcy Court's finding was supported by enough evidence to survive clear error review.   Indeed, the rates charged by Baker Botts were less on a blended rate basis than any of the other firms in the case.   See In re ASARCO, LLC, 2011 Bankr. LEXIS 5487 (Bankr. S.D. Tex. 2011).

However, the Court was not persuaded by the award of fees for defending the fee application.   The Court stated:

We conclude that, correctly read, Section 330(a) does not authorize compensation for the costs counsel or professionals bear to defend their fee applications.

Opinion, p. 13.   The Court based this ruling on the language of section 330(a), which expressly allows fees for preparing a fee application but not for defending one.  

Parties in interest as well as the United States Trustee are entitled to receive notice and the opportunity for a hearing to question bankruptcy professional fees. Section 330(a)(1). Implicit in this procedure is the possibility of fee litigation. Nevertheless, Section 330 states twice, in both positive and negative terms paraphrased above, that professional services are compensable only if they are likely to benefit a debtor’s estate or are necessary to case administration. Matter of Pro-Snax Distributors, Inc., 157 F.3d 414, 418 n.7 (5th Cir. 1998). The primary beneficiary of a professional fee application, of course, is the professional. While the debtor’s estate or its administration must have benefitted from the services rendered, the debtor’s estate, and therefore normally the creditors, bear the cost. This straightforward reading strongly suggests that fees for defense of a fee application are not compensable from the debtor’s estate. The Eleventh Circuit adopted this interpretation in a factually similar case, holding that “. . . the issue is whether the services rendered were reasonable and necessary to the administration of the estate. [internal citation omitted] The answer to this question is no. The subject of the [appeal and cross-appeal] was the fee to be paid to [the professional] for his services rendered in the administration of the estate. The appeals brought absolutely no benefit to the estate, the creditors, or the debtor.”(citation omitted).  

Further supporting this interpretation is Section 330(a)(6), which limits potential professional fees in two ways. First, the specification of an award for “preparation of a fee application” is clearly different from authorizing fees for the defense of the application in a court hearing. Second, tailoring the award to the “level and skill reasonably required to prepare the application” emphasizes scrivener’s skills over other professional work. It is untenable to construe this language alone to encompass satellite litigation over a fee application. Had Congress intended compensation for professional fee applications to be allowable as “reasonable and necessary” under Section 330(a)(3)(C), there would have been no need to create the limits specified in subdivision (4). The broad reading of Section 330(a)(3)(C) urged by Baker Botts would render Section 330(a)(4) superfluous.

Opinion, pp. 13-14.   The Court then explained how the American rule weighed against fees for defense.

Because Congress designed fee shifting provisions in express derogation of the American Rule that each party to litigation bears its own costs, the losing party should bear the full costs of counsel for the winner. In bankruptcy, the equities are quite different. Both the debtor and creditors have enforceable rights, and there is a limited pool of assets to satisfy those rights and compensate court-approved professionals; in certain cases, moreover, professionals paid from the debtor’s estate represent competing interests. No side wears the black hat for administrative fee purposes. In the absence of explicit statutory guidance, requiring professionals to defend their fee applications as a cost of doing business is consistent with the reality of the bankruptcy process. The perverse incentives that could arise from paying the bankruptcy professionals to engage in satellite fee litigation are easy to conceive.  (emphasis added).

Opinion, p. 16.

The Court dismissed the argument that denying fees for defense of a fee application would encourage excessive fee litigation with the comment that

Too frequently, court-appointed counsel for debtor[’s] and the official creditor committees’ interests in a case, sharing the mutual goal of securing approval for their fees, enter into a conspiracy of silence with regard to contesting each other’s fee applications. (citation omitted).

Opinion, p. 18.  Nevertheless, the Court allowed that fees for defense could be allowed where "an adverse party has acted in bad faith, vexatiously, wantonly, or for oppressive reasons."   Opinion, p. 19.

Thus, the final result was that Baker Botts was able to retain its enhancement of $4.1 million but lost its fees for defense of $5 million.   Jordan Hyden fared slightly better, retaining its enhancement of $125,000 while having $15,000 in cost of defense fees cut.   The Court tried to place this loss in context, stating:

In this case, the huge cost of defending Baker Botts's core fees seems a drastic reduction in absolute terms, but it amounts to only about 4.4% of the core fee.

Opinion, p. 17.   Thus, the message to Baker Botts from the appellate court was you did an amazing job, but you still have to pay the cost of proving that you did an amazing job.

Take-Aways from the Opinion

While this opinion addresses two very discrete issues, the extensive discussion contains some important lessons about attorneys' fees in bankruptcy.

1. The accolades heaped upon Baker Botts are a measure of respect for the bankruptcy profession.   Even though Baker Botts plays in a more rarified world than the average bankruptcy practitioner, recognition for one bankruptcy professional is approval for the profession as a whole, just as incompetent, dishonest or mercenary behavior by bankruptcy lawyers tends to diminish it.    
2. The Fifth Circuit has re-affirmed the unique amalgamation of three tests first announced in Pilgrim's Pride.   Professionals litigating attorneys' fees in the Fifth Circuit cannot simply rely on the language of the statute, but should consider whether the other two tests enhance or detract from their position.
3. The Court's comments about national vs. regional fees reflect a compromise position between the efficiency of administration standard under the Bankruptcy Act and the "greed is good" mantra of Gordon Gecko.    While bankruptcy is no longer the poor stepsister of the legal practice, professionals cannot charge amounts exceeding the local prevailing rate simply because that is what they charge in some other, more expensive jurisdiction.
4. The Fifth Circuit mentioned Pro-Snax, but not for its most infamous holding.   While the lower courts have struggled to implement the "tangible, identifiable and material benefit" standard, the Fifth Circuit has not revisited this language since its 1998 debut.   In this opinion, the Court mentioned one of Pro-Snax's less controversial statements that fees must be likely to benefit the estate or necessary to administration in order to be compensable.  This may be a signal from the Circuit that it will focus on the parts of the opinion that are uncontroversial while de-emphasizing the questionable language.     
5. The Court recognized that challenging another professional's fees, while distasteful, is an important part of the process.   The Court's warning against the "conspiracy of silence" as well as its no black hats in fee litigation suggest that professional fees should be exposed to the same adversary process as other facts required to be determined by the courts.   While it may be easier to let the U.S. Trustee or the bankruptcy court do the heavy lifting, the parties will often have the most knowledge and incentive to develop the record.